Economics of climate: Step back from ideology

What is economics, in essence?

It is an optimization problem. You choose your measure of interest and make it as good as possible.

From there, opinions vary. What is your measure of interest? Some say growth – the rising tides raise all boats crew (they have never had a leaky boat). Others say equity – inequality they say is not an acceptable price for growth. Sustainability is another measure: it is all very well to pursue maximum growth, minizing inequality, maximizing access to quality health and education or whatever other goal you seek if, in the long run, everything falls apart.

The optimization problem and the hazard of local maxima.
Assume your score of interest is good if it is big. At points
A and B, getting better takes you to a place that is not the best
because you have to first pass through a point where things

look worse

 

There are two difficulties with simplistic markets-vs-socialism comparisons. First, not everything is an economic good. A social good may not have a monetary value and also may not be promoted by pure economic growth. Another problem is that a market is good at finding local maxima, and disadvantages players willing to endure short-term pain to reach a more optimum point.

Markets favour local optimization

Check out the picture.

Assume you are in an industry where players have achieved efficiencies that put them at point A or B. If they are under competition pressure, their best strategy is to move to the “local maximum” because moving in that direction makes them more competitive. If they attempt to move to the point marked “best?” they first have to move through a stage of getting worse.

This is in very generic terms – to make it concrete, if a totally new way of operating is proposed that is way more efficient than traditional practice but it takes a big investment to implement, anyone adopting the new concept goes through a period where they incur extra costs in making this investment. They therefore move away from the local maximum and head down the “worse” slope. Then, once the new investment starts to pay off, they need to make improvements to get ahead of the competition who is still playing in the “local maximum” space.

Social vs. Economic Foods

Some things either do not have a monetary value or are too important to leave to the possibility that the markets will fix them. One example is health. Up to a point, you can trade being healthy for having more money but debilitating or life-threatening conditions are things you would rather fix the best way possible that worry about the cheapest option. More broadly, a healthy population benefits society. Essential work is not left undone because someone is sick, etc. Much the same can be said for education. Though being educated confers personal advantage, society as a whole benefits from a more educated population.

Can markets alone optimize social goods? No. Because access to resources does not neccessarily correlate with ability. The stupidly rich can benefit from education even if they have very little potential. If the extremely poor get ill, they cannot be expected to work extra time while still sick to pay medical bills.

A borderline case is negative externalities, costs that do not fall on a producer but that cost society. These are economic costs but are not well-suited to the market model as the cost can be passed on to society. Examples include pollution and depletion of natural resources.

Climate Change

Where does climate change fit into all of this?

First, the cost is a negative externality, something that the markets demonstrably do not handle as they have not fixed the problem. Second, it is a social cost as it damages the poor disproportionately and generally will damage those not responsible for the problem. Third, it illustrates the problem of local optimization neatly. While it is increasingly plausible that renewable energy in the long run will cost less than fossil fuels – particularly when cheap sources deplete – in the short term the “worse” cost scenario has to be covered somehow, otherwise renewables cannot build to the sort of scale needed.

Some fundamentalist libertarians argue that climate science is flawed because it requires a large-scale government intervention. I argue the opposite. Their economic philosophy is flawed because it cannot remedy a situation like this. So instead of allowing someone else to fix the problem, they deny.

Agang: a new direction for South Africa?

In the wake of the announcement by activist and business leader Mamphela Ramphele that she is working on launching a new party called Agang in South Africa, my worry is that most of the emphasis is on where the ruling ANC is going wrong.

That’s not enough. We need a positive principled alternative. Since the collapse of the Soviet Union, politics in many countries has become a principle-free zone, as the space for alternatives on the left has closed off, and the mythology that the Soviet Union collapsed because robber baron capitalism is the best system has taken hold. The reasons for the collapse of the Soviet Union are another whole discussion: the worldwide economic downturn in 2008 is evidence that we have not arrived at an alternative that represents perfection.

In essence, the major western economies have become trapped in the Reagan-era mindset of greed is good, and seem unable to deal with the obvious fall out from the failure of deregulated economics. A big part of the problem is that once you enter a principle-free zone, the temptation is to follow the line of least resistance: say or do whatever plays well to polls and focus groups.

What we need is a new set of principles that has a practical base, yet takes us beyond doing whatever seems expedient.

My aim here is to get the discussion started; I welcome other views on the principles that could be the basis for a new movement.

I like the pillars of Green politics, which I like to summarize as:

1. grassroots democracy
2. environmental and economic sustainability
3. economic and social justice
4. nonviolence

There are many variations on these principles; you may notice I put the word “economic” in two of them. That’s not because I place the economy ahead of everything else, but because we need to consider the economy in the context of both sustainability and social justice. An increasing number of economists capture this concept in the notion of a triple bottom line, the idea that you cannot express economic wellbeing by a single number reflecting financial well-being but you also need to consider whether your economic policies are working for the environment and for social goals.

Let’s look at these principles in detail and see how they apply to South Africa.

Grassroots democracy
Much of the “better life for all” promise of the ANC has been subverted to a better life for a few. We need to take back the instruments of policy that have been subverted to the interests of a small group, and place the well-being of the country as a whole back at the centre of policy-making. To do this, we need accountability, which is not achievable with a Chinese-style top-down interpretation of democracy, where the only election that counts is the selection of the leader of the ruling party.

Grassroots democracy does not mean every issue is decided by popular vote, but rather that when decisions are taken, the whole population’s views are taken into account, and decisions are taken after real consultation, not the fake kind where the outcome is predetermined, and public participation cannot change it.

In a political movement, all positions should be elected, and policy should be an outcome of open internal debate, not a fake consensus imposed from above. In government, a ruling party has to compromise to some extent because those in charge must make decisions on day to day running of the country, which most citizens lack the time to keep up with. The corrective here is maximum transparency: doing away with relics of the apartheid security state that make it possible to hide behind fake secrecy requirements, for example.

Environmental and Economic Sustainability
A crucial series of questions to ask is:

• Is what we are doing still going to work for future generations?
• Are we stealing from our children and grandchildren?
• Are we consuming resources that will never exist again, with no thought of what will replace them?

If we do not ask these questions, and provide satisfactory answers, the promise of a better life for all is a hollow sham. The apartheid regime only tried to service 10% of the population. Since 1994, that 10% has not expanded in a meaningful way. While school attendance has increased, many resources to pull students out of disadvantage have been squandered or misapplied. There has been no serious attempt at building an affordable public transport network, or encouraging use of low-cost modes of transport like bicycles, leaving the poor at the mercy of commercial operators (taxis and long-haul buses), which operate at their convenience not that of their passengers. Unemployment remains stubbornly high.

We also are moving at glacial pace to reduce our dependence on fossil fuels. If we cannot transition to energy sources with a long-term future, much of our population will remain excluded from a modern economy. Oil, coal and gas are depleting commodities, and will become ever-more expensive. The price gap between renewables and fossil fuels is closing fast, and we are not positioning ourselves to take advantage when the gap closes fully and renewables start to become cheaper. We have some of the best solar energy resources in the world, and are making scant use of them.

A greener economy in the short term is more labour-intensive because of the new infrastructure needed. So why are we waiting?

Economic and Social Justice
In the apartheid era, the economy was radically skewed to support the White population, and the rest of the population were excluded from the economy by a variety of measures, including limited land ownership, limited opportunities to own business, deliberately sub-standard education and limited access to better-paying jobs.

While some of these limits eased in later apartheid years (e.g., the dropping of job reservation and group areas), we have a long-term legacy of the majority of the population lacking a quality education and a capital base from which to grow.

Black economic empowerment (BEE) under the ANC has been a system of riches for the few, while leaving the majority with little or no opportunity for betterment. We need a change in emphasis to make the benefits more widespread. That has to include:

• systematic reform of education – noting that some of the country’s worst-resourced schools produce creditable results
• there has to be a management problem that makes so many others perform so poorly
• the huge disparity in performance by province also indicates a management problem
• professionalising the public service – the public service first and foremost is the engine of delivery of government services, not a job-creation programme. Placing services that are critical to opening up economic opportunity in the hands of the politically connected rather than those best qualified to provide those services is not BEE, it’s corruption

None of this precludes affirmative action in government employment, but that affirmative action cannot take the form of cadre deployment with no consideration for competence.

Non-Violence
Non-Violence is not just about conducting peaceful protest (Ghandi-style). It is also about a public discourse that steers away from unnecessary confrontation.

Politics in a principle-free zone has increasingly become personalised. While anyone in the public space whose private life is indefensible has set themselves up for unwanted scrutiny, that should never be the sole basis for evaluating political leadership. That reduces political discourse to gossip, and turns leadership into a cult of personality (or lack thereof).

Nor should we be using war talk as routine campaign language. And a party of government should not be building up military capability to be in a position to engage in wars of aggression.

A country like ours with a violent past and a legacy of a police state that valued the lives of some far less than others needs to put strong emphasis on the equal value of every life, and that precludes policies and rhetoric like “shoot to kill”, a mentality that the police showed can have disastrous consequences at Marikana in August 2012.

A country’s military should primarily be an emergency force able to respond on short notice to disasters, with the potential to take part in genuine peace-keeping and democracy-building interventions.

We all need to work to undo the culture of violence with deep roots in colonialism and apartheid. We cannot point fingers back to the cause and fail to address in ourselves an inability to move on.

Where does this take us?
Let’s start talking what we want, not just what we are against, then we have a movement.

COPE was essentially only about where the ANC had gone wrong, and look how that ended.

Climate Change, Peak Oil and the Meltdown

Some people are already talking about how mitigating climate change is a luxury that will have to await recovery from the economic meltdown. That is loser talk. Governments at least in countries with sound economic management that haven't run up massive debt can and should look at this as an opportunity for long-term infrastructure spending. And what better way to plan for the future than to reduce the future impact of higher energy costs and climate change mitigation?

Here are a few ideas for consideration. First, funding efficiency drives will gear the economy for future competitiveness.

Another idea is to fund free solar hot water for 100,0000 and free solar power for 40,000 low-income households (each at a cost of about $400-million); both would generate jobs and save poorer people money. Why is this a better idea than existing Australian state and federal rebates? Because there rebates cause no downwards price pressure; the price rises to whatever the market will bear. I've seen solar water heaters in South Africa for sale at less than the post-rebate price in Australia. If the government buys a large number of systems and pays for installation, the vendors will build economy of scale, then have to drop prices to continue with that scale in the broader unsubsidized market. To me this makes more sense than an ongoing price subsidy, the effect of which is to keep prices high.

Of course "free" doesn't mean no one pays for all this; it comes out of our taxes. But the same is true of roads, the vast majority of which don't have tolls. Building roads contributes to carbon emissions yet somehow "free" roads are acceptable to some, where a plan like this is seen as somehow wrong because someone is getting something for nothing. I wonder, do the same people argue that you can't mitigate climate change because the poor will suffer the most from extra costs of energy?

The government should support development of sustainable biomass and wind turbines on farms. Measures here could include direct subsidies and decent feed-in tariff policies for supplying clean energy to the grid. Both interventions would generate an income stream for farmers, reducing the pain of higher energy costs for their operations. Good for the environment, good for the economy. There are some interesting biofuels options out there. Legumes for example do not need nitrogen fertilizer. Peanuts are one of the oldest sources of biodiesel; better still are legumes that grow on land unsuited to food crops, such as the Pongamia tree.

Improved urban public transport should be another priority. Again, it creates more jobs, is better for the environment and reduces the impact of high energy costs on those on lower incomes. Add to this putting more services into outer suburbs to cut travel distances. Again good for the environment, good for the economy, good for those on low incomes.

Better inter-city rail is a longer-term project. But why not start planning now? What will we do when air travel becomes prohibitive? Already, fast trains are competitive in time for travel up to 1,000 km, allowing for the inconveniences of getting to and from airports and on and off planes. Europe and parts of the Far East already have this infrastructure; countries like Australia and the US need to catch up, otherwise they will be severely disadvantaged in sectors of the economy where medium-range travel is a significant cost.

All of this except the inter-city rail project that would be a longer-term project could be funded for less than the $10-billion the Rudd government is pumping into the economy mainly by cash handouts, as their response to the worldwide economic meltdown.

We have had a brief breather from high oil prices thanks to the financial meltdown, but don't expect it to last (prices are already heading up). Oil is not made by melting down markets ...

The Zeroth Way

Social democrat parties have in recent years (going back to Bill Clinton and Tony Blair, more recently joined by Australian Labor leader and prime minister Kevin Rudd) been espousing the Third Way – supposedly a middle ground between capitalism and socialism. Socialism was widely believed to have failed with the collapse of the Soviet Union and the ascendency of tendencies like Thatcherism and Reaganomics, collectively amounting to a “greed is good” mindset. While supporters of this latter tendency called themselves free market capitalists, in reality, they were happy to support market distortions that supported particular interests. Thatcher herself denied that she was a strictly “laissez faire” capitalist.

Going back to the Third Way, rather than a reformation of social democracy to something less socialist with elements of fiscal responsibility, it was essentially a capitulation, an acceptance that the “greed is good” mindset had won.

With the 2008 Wall Street meltdown and the increasingly obvious problems purely market-based mechanisms are having in dealing with a transition from carbon-based fuels, it becomes useful to rethink the whole economic paradigm again.

With the failure of the Third Way, I advocate going back to basics: considering what humanity is actually collectively striving to achieve. Naturally in the process of doing so, we should not discard lessons of the past: the utility of the market mechanism when it works, the values of social goods such as a healthy society that are hard to quantify in a market and the limits of these mechanisms.

But since I want to go back to basics, I would like to call my approach the Zeroth Way.

What has proved to be a limiting factor on previous economic thought?

The inability to grasp the necessity of handling limits to trends has caused many of the problems we face today. Long-term growth in fossil fuels has led to the peak oil problem. Whether we have reached that point or not is something that will only be clear in hindsight but there is growing evidence that it will soon be impossible for oil supply to continue to meet growth in demand without big price increases, once sources of oil that are cheap to extract deplete. Another difficulty is a lack of understanding that risk in home loans depends on expectations of growth in house prices. While prices are increasing, the risk is low, as in the event of anyone defaulting on their loan, most if not all of the money can be recovered in a forced sale. When prices drop, any doubtful loans turn into liabilities not only for the home owner but for the lender. That same principle applies across many financial instruments: as long as the trend is up, the risk is lower, because failures can be covered by other successes.

The combination of a number of these effects has resulted in a major economic crisis, the like of which has not been seen since 1929.

What is the alternative, the Zeroth Way?

The alternative is to adopt a principle of sustainable economics. “Sustainable” in general terms as a description of a practice simply means that that practice can be continued without any reasonably foreseeable limit. This definition is very general, and can apply to an activity that is constant in time, one that is growing or even one that is shrinking. To give some examples, using solar energy is sustainable in the sense that the sun will continue to be available for as long as a human requirement for energy is likely to be an issue. Growth in demand can be handled up to a very high limit compared with demand today, though ultimately there is a cap. By contrast, fossil fuel use is clearly not sustainable, as we are already running out of some resources, and we are using fossil fuels up at about a million times the rate they were created.

Sustainability in energy terms is a well-known concept, but how does it adapt to economics?

The same definition applies, except the measure we are using becomes an economic measure. For example, returning to mortgages, lending money at a level that requires house prices to rise before the loan becomes secure (in the sense that the loan could be recovered by selling the propery) is not sustainable. Lending at a level that requires prices to be static could even be argued not to be sustainable. The lowest-risk strategy would be to limit a loan to the level that a valuation is likely to hold in any economic scenario short of a total collapse. In practice, this may mean limiting loans to something like 80% of the valuation in normal times, and less when the market was rising rapidly. Naturally banks do not like this sort of restriction, as a rapidly rising market is exactly the scenario where borrowers battle to find a higher fraction of the price as a down payment. However, a sustainability requirement such as this on mortgages would slow down rapid price spikes, and smooth out fluctuations in the market by reducing trends for price spikes to overshoot a reasonable level, and correct downwards. Why not just leave it to the market? Because the market results in the opposite effect to sustainability: practices that only work in a growing market tend to be amplified as growth increases, inevitably leading to a bigger than necessary collapse at the peak of the economic cycle.

There are two important things we have learnt from market capitalism and socialism:

• The market is not good at ensuring sustainability, and
  
• over-complex regulation has a tendency to become an end in itself, failing to deliver the intended benefits.
  

The example of mortgages illustrates a general principle. The notion of discouraging or preventing unsustainable practices could apply more broadly to the economy. The key trick to making the Zeroth Way work is to find simple mechanisms to enforce sustainability. Sometimes very simple measures can have profound effects. For example (I don't claim this example is one of sustainability, but of how simplicity can be effective), the German Reinheitsgebot (beer purity law) was a simple measure that prevented adulteration of beer by specifying the exact allowed list of ingredients. The economic effect was to prevent large-scale monopolistic breweries from forming. Such relatively simple measures have the advantage of simple implementation and enforcement, and avoid the downside of socialism, bureaucratic entanglement.

Why would we want to make this change? A simple answer is that the existing approaches have all failed. A more complex answer is that understanding sustainability in economics terms helps us to avoid considerable human misery. Think of thousands of people losing their homes and jobs in an economic collapse. Think of the hardships of the poor as energy gets expensive. Think of the impossibility of poorer countries ever having the advantages of an energy-intensive economy if the wealthy burn up all the cheap energy.

Another answer is that the market is designed to price short-term fluctuations accurately, and performs poorly when the requirement is to reconfigure the basic settings of the system. For example, agriculture could be severely impacted by rising energy costs (whether from peak oil or from carbon taxes). A solution is to include energy production as an income stream in agriculture. Options include biofuels and placing wind turbines on farms. Biofuels have started to get a bad name because of unsustainable practices, like using food crops as feedstock, and clear-cutting old growth forests to grow fuel crops. Both of these approaches can be avoided; there are options like using agricultural waste, and growing crops on land that is not suited to food crops. Sustainability in this instance is not only in ensuring the continued economic viability of farming by including farmers in energy production, but in ensuring sustainable practices for producing biofuels. Absent interventions like subsidies on research to jump-start new approaches to energy, however, these things will not happen on their own. Left to the market, farmers will simply go broke as costs get too high, as we reach the point where food prices are too high for poorer people, and consumption drops.

All of this is purely a question of sustainable economics. Add in the environment, and there is another important consideration that is often overlooked. Yes, environmentalists can and should worry about our furry and feathered friends in the wild, the great trees in our old growth forests, and the mysterious creatures of the air, the dark forest and deep sea. But we are also a species, and, like any other species, we have a habitat. Destroy that habitat and we destroy ourselves.

The challenge therefore I would like to throw out is to think through other areas of economics where the sustainability principle could apply, and how to enforce that principle with least effort.

Further Reading

There's like thinking in other parts of the world. For example, the Green New Deal idea from the UK is worthy of further study.